The political economy of inflation and stabilization in developing countries

Abstract

The political economy approach to macroeconomic policy has built on some important insights of game theory and the theory of public choice, trying to explain why some governments decide to run large fiscal deficits and to rely heavily on the inflation tax. The purpose of this article is to discuss selectively some of the most important insights of this new literature on policy-making from the developing countries' perspective. The author emphasises the policy implications of this approach to inflationary analysis and discusses some of the limited empirical results on the subject. Section II deals with the role of political instability in determining seignorage and the reliance on inflationary financing across countries. Section III focuses on the role of credibility in inflationary experiences and in stabilization programs, discussing the role of "external agents', including multilateral institutions such as the International Monetary Fund, in the implementation of anti-inflationary adjustment programs. Section IV discusses critically the literature on political business and budget cycles and presents some empirical results for Chile. Section V deals with the political aspects of successful devaluations and stabilization programs. Finally, Section VI contains the concluding remarks and some suggestions for future research. -from Author